Calif. Cap-and-Trade Scheme’s Approach is Troublesome

When the California Air Resource Board (CARB) formally updated its proposed cap-and-trade rules last month, businesses in California and across the U.S. reached a similar conclusion: If left unchanged, the updated rules will undermine California’s offset market by making it significantly more difficult and more costly for businesses to meet their climate goals.

Businesses are particularly concerned about a controversial provision that allows CARB to invalidate offset credits at any time up to eight years after they are issued for what affected businesses view as ambiguous reasons. The provision also puts the liability for replacing invalidated credits on the credit-buyer, rather than the party at fault. This is problematic at various levels. As recently described by the International Emissions Trading Association (IETA), CARB’s buyer’s liability provision is:

Inefficient and unfair: To be efficient and fair, a liability system should impose liability on the party that is most likely to be at fault, the one that has the most information and ability to control performance. In this case, that would be the offset project operators, verifiers or offset project registries. Yet, under CARB’s proposed buyer liability provision, the holder or user of a credit is liable to replace the credit if a discrepancy is found, even if it is not the holder’s fault.

Uninsurable: Some CARB officials see insurers coming to the rescue. This is highly unlikely given that insurers usually require a long track record, a relatively short statute of limitations and a lack of conflict of interest to develop insurance products – none of which exist in this case.

If IETA’s arguments are not convincing enough, consider the disappointing track record of temporary and long-term Certified Emissions Reductions (otherwise known as tCERs and lCERs, respectively) conceived for the Clean Development Mechanism (CDM). A review of these provisions explains the wide concern over CARB’s buyer liability provision.

These are a special class of CERs issued for afforestation and reforestation projects that have expiration dates, after which they must be replaced by another tradable emissions unit approved under the Kyoto Protocol. Temporary and long-term CERs can also be cancelled if verification reveals that the stored carbon they were issued for was released back into the atmosphere.

All well and good, right? Wrong. When tCERs and lCERs were originally conceived, the onus for replacing canceled tCERs and lCERs was put on the credit buyer rather than on the project developer. This should sound familiar: It is almost exactly the same approach CARB is proposing to address the unlikely but possible invalidation of its own offsets.

This is where the analogy really becomes meaningful. Because of the challenges inherent in buyer liability, tCERs and lCERs have been subject to significant price uncertainty, making them wholly unpopular with buyers. The European Union Emissions Trading Scheme (EUETS), the largest emissions trading scheme in the world, prohibits compliance entities to use such credits. In fact, as of August 2011, afforestation and reforestation projects accounted for just 28 out of 3,337 registered CDM projects, according to the United Nations Environment Programme.

This is something CARB cannot afford to have happen to its own offset program, particularly given that CARB’s buyer liability provision applies to its entire offset supply, not just to a sub-segment of it (as is the case in the CDM). To continue with buyer liability, CARB would risk a shortage of offset supply and therefore a huge increase in costs for Californian businesses and subsequently Californian consumers. As indicated by CARB’s own economic analysis, Californian businesses would face a carbon price of roughly $150/ton by 2020 if left without carbon offsets, as compared with $30/ton with sufficient supply.

Fortunately there are alternatives to CARB’s buyer liability approach that would avoid the unintended consequences that afflicted tCERs and lCERs. The most notable and widely supported alternative is the buffer approach already used by standards like the Verified Carbon Standard, Climate Action Reserve, the American Carbon Registry, and even CARB, to address the risk of non-permanence in forestry projects. The introduction of the buffer approach has been a crucial step in increasing liquidity in the forest carbon market. As a business with a long history in forest carbon, dating back to the late 1990s, it was one of the key factors in The CarbonNeutral Company’s decision to re-enter the forest carbon market in 2009.

So where does that leave us? Well, for the sake of Californian businesses, rate payers, offset project developers and the rest of the carbon market, I sincerely hope CARB learns from Europe’s past mistakes and finally does away with its buyer liability provision.

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Jem Porcaro is the senior vice president of the CarbonNeutral Company.